Busting the seven key myths about bonds Myth #3. Bonds are too risky

Over the last 20 years, the FIIG team has had thousands of conversations with investors who are considering investing in bonds and other fixed income investments.

We’ve come to recognise some key misconceptions that investors quote when discussing a potential investment, most of which are based on false assumptions. So, if you’re still unsure about bonds, this series of articles which delves into the “Seven Key Myths” may help.

Reality #3 Comparing like for like, in the same company, bonds are less risky than shares.

Famous investor Benjamin Graham once commented that investors should never have more than 75% shares in their portfolio and never less than 25% bonds and they should also never own more than 75% bonds and never less than 25% shares.

Australian SMSFs, however, do not hold even close to Graham'’s recommended level, with around 1% in bonds. This is in stark contrast to investors in the US, UK and Europe who hold much higher allocations. Much of the reason for this is a lack of understanding of the fundamental truth about bonds versus shares: the two different asset classes complement each other.

Bonds are lower risk than hybrids and shares in the same company and help to protect your capital. The reason is that if a company gets into trouble and is wound up, there is a legal structure dictating how cash and the proceeds of asset sales are applied.

In the event of wind-up or liquidation, funds are paid to the most senior investors in the capital structure (senior secured debt) first and these investors would typically need to be repaid in full before any funds are paid to investors on the next level. Then each level must be repaid in full before funds are paid to the next level (see the diagram below).

The position of your investment in the capital structure is crucial in determining its risk and whether the return you are receiving is enough.

Shares are expected to deliver growth and higher returns than bonds but they are the highest risk investment in the capital structure and returns (either from capital appreciation or from dividends) are uncertain. In contrast, fixed income securities sit higher in the structure, are safer in the event of wind-up or liquidation and are designed to deliver a known return. These characteristics means that generally they are lower risk and offer lower returns than shares.

Including bonds and other fixed income securities in your portfolios should lower risk and volatility and help smooth returns.

So, if your portfolio is just shares and deposits, you’re missing out on all of the other rungs in the capital structure and the benefits of those investments.

Disclaimer The contents of this document are copyright. Other than under the Copyright Act 1968 (Cth), no part of it may be reproduced or distributed to a third party without FIIG’s prior written permission other than to the recipient’s accountants, tax advisors and lawyers for the purpose of the recipient obtaining advice prior to making any investment decision. FIIG asserts all of its intellectual property rights in relation to this document and reserves its rights to prosecute for breaches of those rights.

Certain statements contained in the information may be statements of future expectations and other forward-looking statements. These statements involve subjective judgement and analysis and may be based on third party sources and are subject to significant known and unknown uncertainties, risks and contingencies outside the control of the company which may cause actual results to vary materially from those expressed or implied by these forward looking statements. Forward-looking statements contained in the information regarding past trends or activities should not be taken as a representation that such trends or activities will continue in the future. You should not place undue reliance on forward-looking statements, which speak only as of the date of this report. Opinions expressed are present opinions only and are subject to change without further notice.

No representation or warranty is given as to the accuracy or completeness of the information contained herein. There is no obligation to update, modify or amend the information or to otherwise notify the recipient if information, opinion, projection, forward-looking statement, forecast or estimate set forth herein, changes or subsequently becomes inaccurate.

FIIG shall not have any liability, contingent or otherwise, to any user of the information or to third parties, or any responsibility whatsoever, for the correctness, quality, accuracy, timeliness, pricing, reliability, performance or completeness of the information. In no event will FIIG be liable for any special, indirect, incidental or consequential damages which may be incurred or experienced on account of the user using information even if it has been advised of the possibility of such damages.FIIG Securities Limited (‘FIIG’) provides general financial product advice only. As a result, this document, and any information or advice, has been provided by FIIG without taking account of your objectives, financial situation and needs. FIIG’s AFS Licence does not authorise it to give personal advice. Because of this, you should, before acting on any advice from FIIG, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If this document, or any advice, relates to the acquisition, or possible acquisition, of a particular financial product, you should obtain a product disclosure statement relating to the product and consider the statement before making any decision about whether to acquire the product. Neither FIIG, nor any of its directors, authorised representatives, employees, or agents, makes any representation or warranty as to the reliability, accuracy, or completeness, of this document or any advice. Nor do they accept any liability or responsibility arising in any way (including negligence) for errors in, or omissions from, this document or advice. FIIG, its staff and related parties earn fees and revenue from dealing in the securities as principal or otherwise and may have an interest in any securities mentioned in this document. Any reference to credit ratings of companies, entities or financial products must only be relied upon by a ‘wholesale client’ as that term is defined in section 761G of the Corporations Act 2001 (Cth). FIIG strongly recommends that you seek independent accounting, financial, taxation, and legal advice, tailored to your specific objectives, financial situation or needs, prior to making any investment decision. FIIG does not provide tax advice and is not a registered tax agent or tax (financial) advisor, nor are any of FIIG’s staff or authorised representatives. FIIG does not make a market in the securities or products that may be referred to in this document. A copy of FIIG’s current Financial Services Guide is available at www.fiig.com.au/fsg.

An investment in notes or corporate bonds should not be compared to a bank deposit. Notes and corporate bonds have a greater risk of loss of some or all of an investor’s capital when compared to bank deposits. Past performance of any product described on any communication from FIIG is not a reliable indication of future performance. Forecasts contained in this document are predictive in character and based on assumptions such as a 2.5% p.a. assumed rate of inflation, foreign exchange rates or forward interest rate curves generally available at the time and no reliance should be placed on the accuracy of any forecast information. The actual results may differ substantially from the forecasts and are subject to change without further notice. FIIG is not licensed to provide foreign exchange hedging or deal in foreign exchange contracts services. FIIG may quote to you an estimated yield when you purchase a bond. This yield may be calculated by FIIG on either A) a yield to maturity date basis; or B) a yield to early redemption date basis. Some bond issuances include multiple early redemption dates and prices, therefore the realised yield earned by you on the bond may differ from the yield estimated or quoted by FIIG at the time of your purchase. The information in this document is strictly confidential. If you are not the intended recipient of the information contained in this document, you may not disclose or use the information in any way. No liability is accepted for any unauthorised use of the information contained in this document. FIIG is the owner of the copyright material in this document unless otherwise specified.
The FIIG research analyst certifies that any views expressed in this document accurately reflect their views about the companies and financial products referred to in this document and that their remuneration is not directly or indirectly related to the views of the research analyst. This document is not available for distribution outside Australia and New Zealand and may not be passed on to any third party without the prior written consent of FIIG. FIIG, its directors and employees and related parties may have an interest in the company and any securities issued by the company and earn fees or revenue in relation to dealing in those securities.

Director – Education and Research
Elizabeth is considered an expert in the fixed income asset class and is a regular contributor to The Australian. She frequently writes for and is quoted in other press.

Subscribe to The WIRE newsletter

About FIIG

At FIIG, fixed income is our sole focus. We enable investors and issuers to directly access a broad range of fixed income products and services. Not only do our customers have the most up to date market research and the expertise of our in-house professionals at their fingertips, they also have access to deposit rates from an extensive range of APRA regulated banks, credit unions and building societies. At FIIG we're guided in everything we do by our clear and single-minded purpose: Creating access to fixed income investments you can trust.

FIIG provides general financial product advice only. For a copy of our disclaimer please refer to fiig.com.au/disclaimer* Based on FIIG’s high yield sample portfolio. Click here to view. Subject to change and before fees. Please see our FSG for any applicable fees.